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IBM Investors Unconvinced Even as Growth Signs Reappear

IBM Investors Unconvinced Even as Growth Signs Reappear

By Jing Cao, Bloomberg | Updated: 18 October 2016 10:44 IST

IBM came the closest in more than four years to reporting quarterly revenue growth on Monday, a sign that Big Blue may finally be about to turn its business around. Yet investors reacted negatively, with the shares dropping as much as 3.7 percent in extended trading.

The problem may be declining profits and continued skepticism that seemingly positive signs - growth in some businesses and top- and bottom-line numbers that were better than analysts' estimates - don't paint an accurate picture of the fundamental health of International Business Machines Corp.

While operating gross profit margins narrowed for the fourth consecutive quarter, the company reported earnings per share that were better than projected, buoyed by larger than expected income from intellectual property. Meanwhile, acquisitions helped revenue in the quarter by 2 percentage points, highlighting how much of IBM's growth is boosted by inorganic sources.

"Based on the questions around the IP income, it sounded like certain analysts thought the IP payment was one-time which may have contributed to them beating earnings and the pressure on the stock," Anurag Rana, a Bloomberg Intelligence analyst, said in an interview. "Margins were below estimates, but they beat by 6 cents, so where is that beat coming from?"

One-time profit boosts would mean that earnings coming from the core businesses are weak. Similarly, some analysts have expressed concern that growth -- especially in software -- may be stagnating and masked by a quicker acquisition pace in the last couple of years.

Subscription Revenue
IBM Chief Financial Officer Martin Schroeter has said that margins will be pressured in the near term as the company shifts its sales to more subscription-based software and cloud services, but has yet to offer any guidance on when they might recover. He also said Monday that the bulk of the business added from the pay-as-you-go subscription model was organic. While software revenue received some help from acquisitions, he didn't specify how much.

As for the intellectual property question, "we're more successful in monetizing our software through IP income," Schroeter said on a conference call with analysts, explaining that IBM doesn't see it as a one-time boost. "We see an opportunity over the next few years to continue doing this."

Since Chief Executive Officer Ginni Rometty took the top post in 2012, investors and analysts have been waiting for what some call the "inflection point," where the growth in and size of newer businesses exceed the declines in the older ones. Returning to revenue growth would be an indicator that IBM has reached this point, and the Armonk, New York-based company reported only a 0.3 percent decline in sales in the third quarter. That's why Dan Morgan, senior portfolio manager at Synovus Securities Inc., was surprised by the negative stock reaction.

"The numbers were pretty good," Morgan said. "They even showed positive growth in the different segments, which I wasn't looking for in this quarter." Synovus holds IBM stock.

Plus, declining earnings aren't necessarily a bad thing while IBM shifts its business, Rana said, pointing out that profit margins at Microsoft Corp. had also taken hits while it worked on moving to selling mainly cloud software and services.

"As businesses shift, as models shift, it all comes down to whether these guys have the portfolio of products to grow the business," he said. "There will be pricing pressure on some of these services, and at the end of the day, if this is leading to potential for these guys to grow in a couple years, that's not a bad deal."

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